RESEARCH CONTENT
The Bank of Japan pressed the smallest possible button on Monetary Policy, removing negative rates but keeping them as good as zero. A “Zero Interest Rate Policy” ZIRP remains in full force.
More importantly for asset price valuations, the BoJ confirmed it will:
Continue to buy JGBs with broadly the same amount as before
Discontinue purchases of ETFs and J-REITs
Reduce the amount of Corporate and CP bond buying
Provide loans to “stimulate bank lending”,
Two big takeaways/lessons:
1) the BoJ will continue to expand its balance sheet to support the financing of the government deficit, thereby reducing the need for private sector savings to do so which would impact private sector asset valuations. Just as key, it will also continue to refinance existing debt – something not to be taken for granted or underestimated. In other words, QE is still in play even if unofficially YCC might not be used as a term, so the yield on JGBs should be capped to the upside.
2) The last comment on stimulating bank lending is a reminder to the rest of the world that just because rates are low, private sector does not necessarily grow. Remember how poor bank lending was in the US and Europe in the post GFC ZIRP years? The BoJ have seen this first hand for 30 years and are doing what they can to stimulate bank lending as they know the importance for economic growth.
The BoJ action, as expected (see previous GFH research), did nothing but confirm that they are trapped and that the market should expect more of the same going forward. That means continued low bond yields, risk assets maintaining their values and the currency being debased.
I have received some questions from clients about the Endgame, and how does this all finish? Surely this cannot go on for ever.
I have been following Japan since 1990 and one big takeaway is that the road to kick the can down is very long, principally due to the internal economy, exports and imports of overseas profits. But looking ahead, the government has 4 difficult choices to make:
Reduce the deficit – difficult with an aging population that requires services and a low worker/non worker ratio. Furthermore the economic cycle is turning, which will make deficit cutting even harder.
Keep the deficit the same, but get domestic savers to fund it. This would be a return to the policy that brought the “Lost Generation”, i.e. debt deflation a’ la Irving Fisher. The Yen would appreciate but private sector assets would suffer as savings would be diverted to fund the government. This is de/disinflationary in nature and deeply unpopular.
Keep the deficit the same, but with the BoJ funding a significant portion of it. The current policy and status quo, as confirmed by the BoJ. The issue is the pressure valve of currency debasement which stokes imported inflation, which eventually will become a problem down the road as the issue becomes exponential. This is classic EM territory.
Restructure the debt with JGB haircuts. This is possible thanks to the debt being predominantly domestically held and in Yen. Pensioners and savers would get hit badly, which would probably impact the government deficit. The reality is that this is political suicide, which is why governments have never tried this in the past and instead gone down the route of deflating the debt through inflation.
In summary, the maths behind a debt trap are impossible to twist – they just leave poor options and politics will decide which one is taken. The BoJ yesterday confirmed that option 3 remains the current policy, and for reasons explained in previous research, the market should simply expect more of the same going forward. Understanding this leads to several market opportunities.